During the course of any given day, I get questions on price outlook for any number of commodities: canola and wheat are the obvious biggies, but also oats, barley, flax, peas, etc. And while I could talk on and on about individual commodity fundamentals, quite frankly during these days of heightened grain market volatility that doesn’t seem to matter as much lately. All markets — stocks and commodities of all kinds— are marching to the beat of the same drummer for now.
Roughly speaking, ProFarmer Canada is near half sold on most commodities and has chosen to take the longer-term view with the remainder. I’m doing my best to ignore the increasing market volatility of recent times (well, I’m trying anyway) amid renewed threats of Chinese monetary policy tightening and crackdowns on speculative activity in China’s food prices.
There is also mounting debt uncertainty over in Europe and the impact of American Quantitative Easing (QE2) that has instilled a suddenly bearish attitude in all equity and commodity markets (stocks, energy, metals, ag sector, you name it) as spec fund managers look to square their books as the month and calendar year draws to a close.
Market conditions have turned quite impulsive at the time of writing (Nov. 19) with trader sentiment shifting rather dramatically between bullish and bearish. All equity and commodity markets seem to be hanging on the next tidbit of news from China on its monetary policy or the EU as it grapples with its suffocating debt issues.
THE CHINA EFFECT
The news at this time seems to be all about China, all the time.
Driving the mid-November sell-off were fears China will raise interest rates and place tighter controls on consumer prices and food commodities to control inflation. A report in theChina Securities Journal, citing unnamed sources, stated the government may unveil a set of controls, including measures to limit consumer price increases and punitive policies aimed at speculation on agricultural products. The report comes amid mounting concerns the country will hike interest rates.
Food costs are at the heart of China’s inflation worries, with the likelihood of price controls building as global agriculture commodities have rallied this year.
Traders say Chinese inflation-fighting measure could dilute the strength of Chinese demand for a range of commodities. At the same time, price controls could reduce the amount Chinese companies are prepared to pay for grains and oilseeds.
China is the world’s largest importer of soybeans and accounted for 61 per cent of total U.S. soy export sales through the first nine weeks of the 2010-11 marketing year. You can see how the China question reflects very directly on price trends in the soy complex, and in turn all other markets, including Canadian canola. China buying has been at the forefront of soybean and soy oil price rallies of the past two months, propelling the commodities to 26- and 27-month highs.
But the recent prospect of China taking a more active role in fighting inflation has triggered widespread selling in every commodity sector. The influence of market fundamentals for individual commodities seems to be temporarily suspended, replaced by fears of China “possibly” slowing what until now seemed insatiable buying now rules trading sentiment. And those fears have triggered massive liquidation of record-large speculative long positions in the ag commodities.
But we have been though these rumoured “threats” of a slowdown in Chinese demand before. We may have experienced a brief pause, but the Chinese inevitably just keep buying.
In fact, when this corrective downside price action in the ag markets finally does subside with the spec long liquidation process exhausting itself, you can bet it will be the Chinese who are there to pick up the pieces as key buyers — albeit at lower prices levels. If there is a sustained need for many commodities in China, as it appears, a tighter monetary policy and price controls wouldn’t likely have a major impact on demand longer term.
So while there are always numerous factors at play influencing commodity markets, China at this time is largely guiding price action.
But also be aware, grain markets have come up a long way since the summer rally began. The fundamental reasons for the large price increases have been well chronicled. The factors include smaller-than-expected corn acreage in the United States, declining U.S. corn yield prospects, a rapid rate of corn use for ethanol, a torrid pace of U.S. soybean exports, rising world vegetable oil demand, a significant decline in wheat production in Russia and Kazakhstan, crop problems here in Western Canada and a poor start for the U.S. winter wheat crop.
La Nia weather conditions have also raised some concern about Southern Hemisphere crops. In addition, overall demand prospects for U.S. commodities were supported by the declining value of the U.S. dollar and rising energy prices.
But the uptrend in crop prices has now stalled with a lot of these fundamental issues, while not necessarily resolved, are now well known and to a large extent factored into the marketplace.
Except for brief retreats, ag commodity futures prices have been trending steadily higher since the end of June. What we are seeing now is a first real downward corrective shock to the system.
Although the uptrend has stalled, there is still a lot of uncertainty about global crop supply and demand conditions. Uncertainty about Chinese demand, U.S. ethanol policy, energy prices, weather, and 2011 acreage may yet result in wild and woolly winter/spring markets ahead and should provide good underlying support for prices after this spec shakeout subsidies.
That said, no market moves in a straight line. For right now, the patience and the resolve of the true fundamental market bulls is being severely tested.
CANOLA MARKET ROUNDUP
At the time of writing (November 19), Winnipeg January canola futures have posted a rally peak on a closing basis of $568.40/tonne (Nov. 9) with Prairie cash bids tapping the $12-per-bushel level before the sudden corrective lower action trimmed $40/t off the futures price in a matter of a week’s worth of trading sessions.
After what inarguably was an awful tumble, canola futures are down only 20 per cent of the rally from the June lows to the November high. But that’s still well within what is defined as a sustained bull market. In fact, with the overextension of the multi-month rally to the upside, a correction of this magnitude is almost deemed necessary.
With respect to the January canola futures, just to have futures come back to test “key” upward trendline support on the price chart suggests canola futures could yet decline another $20 to $30/tonne to the $500 to $510/tonne area.
Some fairly prominent tops have been posted on all farm commodity price charts. ProFarmer Canada has not budged yet from its 50 per cent sold position on 2010 canola production, but farmers behind on sales should be using bounces to the $11-to $12-per-bushel range as an opportunity to catch up. I’m still expecting strong pricing opportunities in the months ahead, but there is probably room for more long liquidation from the spec sector near term to pressure oilseed prices.
Like you, such dramatic moves to the downside make me nervous. And I’m tempted to sell more as a precaution in case something seriously goes wrong. But for now — for better or worse — ProFarmer Canada sits and waits and watches.
In retrospect, if recent grain market highs prove to be the absolute highs for the year, we’ll look back and conclude that aggregate consumer demand for all commodities must have already been curtailed during the course of the fall price run-up.
But what is different today relative to the wild 2008 market peak — at least pertaining to grain and oilseeds — is that individual demand rationing has yet to occur by any measure. On the contrary, tanking prices right now may actually accelerate demand in the cash market on this go-around.
All eyes are on what China may do. Raising lending reserve ratios and/or increasing interest rates is one option. But such a move is like trying to change direction of a sailing vessel.
Selling China’s government-owned grain/oilseed inventory is another option. But this is like a near-term sugar rush to offer the market a quick fix of fresh supply, and eventually state-owned inventory must again be replenished.
The Chinese government is moving quickly to counter its inflation and is publishing its intentions widely. Reports indicate the National Development and Reform Commission (the nation’s top planning agency) and local governments are moving toward several actions, including price controls, consumer subsidies, anti-hoarding and price-gouging rules and a “local responsibility” system that holds mayors responsible for prices of a basket of food items. Speculating on cotton or corn will lead to severe punishments, the news reports say.
China did a version of this in January 2008 where it banned price hikes on refined oil products, natural gas, electricity, home heating, water, gas and transportation. The government tightened its supervision of prices for grain, edible oils, meat, poultry, eggs, feed and other items in wholesale and retail markets.
While markets were initially shocked by this initiative in 2008, (equities plunged 14 per cent in the three months after food price controls started and 22 per cent the three months after coal price controls were introduced), price controls didn’t work in the medium to long term.
Why? Price controls do not enable producers of goods, services, foods and consumer essentials to make margin by selling domestically. As such, production is curbed. Exporting can be an option, but the Chinese government often controls the pace of that too.
Consumers, still seeing affordable prices domestically, carry on with their consumptive behaviour.
Price controls do not trigger true demand rationing, it only defers consumption, which is why price controls only offer a short-term economic reprieve and lead to pent-up demand later on.
We seem to have been here before. Fear of what “might” happen near term is causing speculative money to exit markets in droves. It’s common to find reference and concern to what happened in the 2008 stock market when price controls were set. This is perpetuating early-exit strategies amongst the speculative community. After all, they only deal with the short-term market perspective anyway. The current market response is exactly what Chinese officials want to see — inject fear to eliminate speculative complacency.
The above explanation though offers no short-term reprieve for those that are offside in a falling market or wish they would’ve sold more grain, including canola. But the above comments serve as a macro- view that supports the big-picture assessment of “this isn’t over.” Supportive market fundamentals should eventually reassert themselves; it just might take a couple months to better understand the China demand component.
THE BOTTOM LINE
If history is a guideline, China’s current action is a bump in the price journey. Lower prices now should prevent demand rationing and likely slow potential 2011 acreage growth. However, this event also kills time so that the world can get closer to accessing 2011 crop conditions. In other words, relative to one to three months ago thinking, there’s reason to think that the 2011 fundamental price roof and floor will be lower and higher respectively. It’s a good news/bad news scenario.
Of course, this all assumes there are no crop disasters in the year ahead.
At the time of writing, markets are in a short-term spec long shakeout process. But bullish long-term fundamentals will likely re-exert their influence in time.
MikeJubinvilleispresidentofProFarmer Canada.Formoreinformationvisitwww.pfcan ada.com